Comments

The Obama Administration is approaching a Labor Day dilemma. Unemployment by then will likely be 10 percent nationally, and even higher in states like California and Michigan. The vaunted stimulus bill (ARRA to political professionals) now looks more like a Band-Aid than a jump-start, as the President originally promised. There is a growing risk that it's too little too late. The ballyhooed infrastructure spending of $140 billion is a drop in the bucket compared to cutbacks three times that deep in the housing construction industry alone; the 600,000 jobs expected from ARRA are dwarfed by cumulative unemployment now in the millions. Yet his economic team is too timid to ask a lukewarm Congress for more money, and health care is the top priority this summer.

Investors and traders in the financial markets now sense a growing risk that the economy could stall much longer than previously expected. Last week, stock and commodity prices and Treasury bond yields had all fallen about 10 percent from recent peaks. Those are all leading indicators. There's another whiff of deflation in the air this month. Consumer confidence faltered again as unemployment spreads like a virulent cancer.

Those of us who urged an infrastructure-spend of three times the amount included in the stimulus bill cannot brag now about being right, when the misery is this deep. Rather, it's time to brush off the best ideas from Stimulus I and put them to work. My prior column on Stimulus II is a place to start, but I have some new ideas based on conditions as they are now evolving.

States will run out of relief money in 2010. One risk facing the Obama team is that the unemployment and safety net funds in ARRA will run out before the economy attains what Fed chairman Bernanke calls "escape velocity" in its eventual recovery. That heightens the threat of a downdraft heading into the mid-term elections, as states and counties are forced to lay off even more workers just as things start to turn around. Congress will ultimately need to extend those features of the ARRA law at some point, so the first chapter of Stimulus II needs to begin there.

It's the unemployment, stupid! Key industries are starting to "stabilize" which means they are getting "less worse" each month. Less worse is not "better," however: Going down (with a weak positive second derivative) is still not going up. Autos and housing are two industries now producing at such low levels that they probably can't go much lower. However, the mounting unemployment nationally keeps consumers scared to spend on anything but necessities. For the newly unemployed, spending will shrink even further in industries that have held up better than others. Consumption cannot recover until unemployment bottoms out. Nobody expands a restaurant when unemployment is getting worse.

And guess where a big part of the new unemployment will originate? That's right -- state and local governments, which must now cut spending even further to balance their budgets as tax revenues continue to plummet.
Twelve states are already underwater by $23 billion just one month into the new fiscal year that just started. State budget shortfalls of $350 billion are projected for fiscal year 2010-11, which potentially implies another one to two million of job cuts -- double or triple the jobs that ARRA seeks to save. State and local budgets always lag the economy, and they will drag down the private sector if they don't get more help soon.

Unemployment can be partially reversed in the state and local sector -- with federal aid to re-hire key workers whose jobs were cut in order to balance shrinking budgets. A "federalist" relief bill can provide the funds necessary to re-hire laid-off police officers, firefighters, corrections officers and classroom teachers. For public relations purposes, I would limit the scope to just those four professions, which most taxpayers would consider to be vital. (Sorry about that, librarians, lifeguards and groundskeepers.)

Congress should limit the appropriation to about two-thirds of the total payroll for those laid off, so that we don't bring back deadwood employees. And structurally, federal aid should not subsidize a local payroll level that cannot be sustained when the economy recovers. Recipient governments must accept a maintenance-of-effort requirement to retain these positions as long as their revenues exceed 2009 levels.

This aid needs to run for 18 months because state and local revenues will not recover sufficiently until then, even in the best of scenarios. To assure fiscal responsibility, Congress needs to cut off this funding by formula if unemployment in the employer's region falls below 7 percent before April 2011, or 8 percent nationally. On the other hand, if nationwide unemployment lingers above 10 percent in 2010, the bill should double the spending authority and include other job titles. If state revenues plunge more than 3-5 percent from here in 2010, the aid should be tripled without strings attached because layoffs then will cripple the economy. Economists call this a "built-in stabilizer."

Republicans will strongly oppose any effort by the Obama administration and Congressional Democrats to stimulate the economy with new government jobs in the federal bureaucracy. To them, that's another step toward socialism. That's why the focus must be local government jobs. Republican mayors, governors, county commissioners and school board members will tell their Congressional delegation that it's not "make-work" to re-employ vital public-service workers for an 18-month period to enable the states and localities to get back on their feet.

Muni bond market backstops. My previous columns have already explained how a federal backstop credit guarantee for the municipal bond market is the fastest way to get infrastructure projects moving for waste-free projects that local taxpayers support, without creating government red tape. The federal government can backstop private bond insurance companies to limit its risks, and it can impose strict lending requirements to protect taxpayers' interests. That will provide the tools for California to dig out of its mess -- and spur a host of additional public-works projects that will be accelerated if states and municipalities can borrow money at 3 percent instead of 5 or 6. (U.S.-guaranteed Build America Bonds sold at 4.6 percent with a 35 percent federal interest reimbursement would cost the issuer 3 percent.)

I've explained previously how Congress should attach tight strings to these bond guarantees to satisfy Republican objections and taxpayers' concerns. One of those strings should be a requirement that entities using federal bond guarantees must establish debt service reserves and rainy-day funds when good times resume, so we don't find ourselves in this pickle again in the next recession.

You may use or reference this story with attribution and a link to http://www.governing.com/hidden/Stimulus-II--A.html